Nine out of 10 homeowners in 2023 planned to take on a home improvement project, according to a survey by Today’s Homeowner. Those homeowners expected to pay for their projects in varying ways, with 60.3% using their checking and savings and 37.4% planning to use a credit card. Other options, such as home equity financing (8.6%) and personal loans (8.5%), were less cited.
But if you're taking on a home renovation, like remodeling your kitchen or fixing your roof, it's best to consider all your options. Since both personal loans and home-equity based loans tend to have much lower rates than credit cards, you could potentially save hundreds or thousands of dollars.
What is a home improvement loan?
The term “home improvement loan” is a catchall for several different financing options. Depending on your situation and preferences, obtaining a home improvement loan could mean taking out a personal loan, home equity loan, or home equity line of credit (HELOC).
“Think of a home improvement loan like a financial toolbox to fix up your house. It's money you borrow to pay for renovations or repairs,” said Jeff Rose, a certified financial planner (CFP) and founder of Good Financial Cents.
You can use a home improvement loan to fix major structural issues, upgrade your appliances, repaint the exterior of your house, and more. Whether you want to enhance the functionality or aesthetics of your residence (or both), a home improvement loan can help you do that.
Personal loans for home improvement
You can take out a personal loan to cover almost any expense — including home improvement costs. Personal loan funds get issued as a lump sum, so you’ll have all the money you need for your project upfront. Plus, you’ll have a set number of years to repay the loan in equal monthly installments, making debt payments simple to incorporate into your budget.
Lenders typically offer one- to seven-year repayment terms for the average personal loan, but may offer up to 12-year repayment terms for home improvement loans. Loan details vary from lender to lender, but you may be able to borrow up to $200,000, depending on your financial profile and other factors. You can get a personal loan from a bank, online lender, or credit union.
If you have excellent credit, your personal loan fixed annual percentage rate (APR) — which includes the interest rate and any upfront fees — may be significantly lower than the variable rate on your credit card. However, if you have less-than-perfect credit, your interest rate could be higher, but personal loan APRs typically top out at 36%.
Keep in mind
Personal loans are usually unsecured, meaning you wouldn’t have to worry about asset seizure if you fall behind on payments. But failing to repay your loan damages your credit report and score, potentially making it difficult to borrow in the future.
Learn More: What Is an Unsecured Loan?
Home equity loans for home improvement
A home equity loan is also a good way to finance household repairs and upgrades, if you have sufficient home equity. When you take out a home equity loan, you borrow against the equity — your property’s current value, minus how much you owe on your mortgage — you’ve built up in your residence.
A home equity loan functions similarly to a personal loan. You receive a lump sum upfront and repay the debt over a set term (usually from five to 30 years) in equal installments.
However, that’s where the similarities end. A home equity loan is a secured debt, and your property is the collateral. That means you could lose your home to foreclosure if you don’t repay the loan as agreed. On the plus side, your rate and payment may be lower with a home equity loan since your home secures the loan.
Good to know
Since your house is on the line with a home equity loan, you may get a lower fixed APR than you would with a personal loan. Plus, you may be able to borrow a larger amount than with a personal loan, which may be necessary for extensive renovations.
You can often borrow up to 85% of your equity (though some lenders may loan you more or less).
For example, if your house is worth $500,000, and your mortgage balance is $100,000, you have $400,000 in equity. So, if your lender allows you to borrow 85%, you could take out a home equity loan of $340,000 (if you’re otherwise qualified).
Since the lender needs to appraise the value of your home, home-equity-based loans can take a month or more to close.
Compare: Personal Loan vs. Home Equity Loan
HELOCs for home improvement
A home equity line of credit (HELOC) is another way you can tap into your property’s equity to finance home improvements. Like a home equity loan, you can usually borrow up to 85% of your residence’s equity. However, a HELOC functions more like a credit card, giving you a predetermined credit line you can draw from incrementally rather than a lump sum upfront.
A HELOC has two phases: the draw phase and the repayment phase. During the typical 10-year draw phase, you can borrow what you need from the line of credit up to the limit. Generally, you’ll only need to pay interest at this time. However, your interest could be variable, making the bill more challenging to factor into your budget.
During the repayment phase, which generally lasts 20 years, you’ll pay off the principal and interest due on the account. If you default on your HELOC, however, you could face foreclosure, as your house is also secured as collateral.
A HELOC could be a smart choice if you’re unsure how much money you’ll need to complete your renovation project or if you want the flexibility to tackle multiple projects over time.
“Homeowners can apply for a HELOC of $50k and use a portion of their HELOC to remodel their kitchen,” Marguerita Cheng, a CFP and CEO of Blue Ocean Global Wealth, said. “When the project is completed, they can pay down the balance and then take on another project, like remodeling the bathrooms.”
Compare: HELOC vs. Personal Loan
Note
While it may be tempting to tap into such a large pool of available resources, it’s wise to limit your loan or line of credit amount to only what you need. It’s still debt you must repay, and you’re taking on risk by using your property as collateral.
How to apply for a home improvement loan
Your home improvement loan application process will vary based on the type of financial product you select.
“Applying for a personal loan is usually a breeze — less paperwork and mainly a credit and income check,” said Rose. “But for a home equity loan or HELOC, it's more of a marathon. They'll want to appraise your home, and they'll dig deeper into your finances.”
Here are some general steps to follow, regardless of what type of home improvement loan you’re after:
- Improve your financial profile before applying: Checking your credit report for errors, paying down debts, and paying bills on time can all improve your chances of loan approval.
- Research and compare lenders: Cheng advises starting with your current mortgage servicer or financial institution. You can also read articles about the best personal loans or best home equity-based financial products.
- Prequalify: You can generally prequalify with multiple lenders, and it won’t affect your credit score. It should be noted that prequalification is not an offer of credit, however, and your final rate could be different once you formally apply. Applying for a loan will cause your credit score to drop by a few points temporarily.
- Get approved: Depending on the lender, your online personal loan application could get approved quickly, and you may be able to get your funds within a business day or two. On the other hand, obtaining a home equity loan or HELOC can take a month or more, though it varies from bank to bank.
Keep in mind that you may have to compensate your lender to secure the financing you need beyond paying interest. For example, some personal loans have origination fees of up to 12% of the loan amount to underwrite and issue the loan. The fee typically gets deducted from what you’re borrowing, reducing the amount of money you have for your renovation projects.
Home equity loans and HELOCs come with closing costs that could add five percent or more to the cost of the loan or line of credit, and you might also have to deal with other expenses. For example, your HELOC may charge a maintenance fee or an account inactivity fee.
The bottom line
Understand and weigh all the costs of a particular loan before finalizing the transaction.
Personal loans vs. equity-based home improvement loans
Which is best?
There’s no hard and fast rule about what type of home improvement loan you should get. The best financial tool depends on your situation and preferences.
For example, if the idea of risking your home will keep you up at night, or you need the money quickly, a personal loan may be your best bet.
On the other hand, if you’re confident in your ability to repay the debt and want to borrow a larger lump sum, a home equity loan could be the right fit. Finally, if you want a more flexible borrowing option, you may wish to apply for a HELOC.
Alternatives
You can also tap your home equity through a cash-out mortgage refinance. With a cash-out refinance, you take out a new mortgage that’s large enough to pay off your existing mortgage and leave you with cash left over for home improvements. However, in the current housing environment, your new home loan may have a significantly higher rate than your existing mortgage, so factor in that potential cost.
Rose also said he encourages potential borrowers to check out government borrowing options, like the Federal Housing Authority 203(k) or Title I programs. Both are designed to help low- and moderate-income earners repair or improve their homes.
A 203(k) loan can cover the home’s purchase or refinance as well as the repair cost, while a Title I loan can only pay for the property’s renovation or upgrade. If you’re buying a fixer-upper, you can use both programs together.
However, if you need less than $25,000 to fix your current residence, the Title I program can stand alone. Loans under $7,500 can be unsecured, while loans over that amount will result in a lien on the property.
Aside from these options, you can also consider a personal line of credit, which operates similarly to a HELOC, except your house is not secured as collateral.
Tip
You can also avoid taking on debt entirely. Cheng said using windfalls like bonuses or tax refunds may help you cover home improvement expenses in cash. Regular and systematic savings efforts can further bolster your house upgrade fund.
FAQ
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Is a personal loan or credit card better for home renovation?
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